How Cambridge Associates Selects Investment Managers

It’s a pleasure to revisit our exclusive conversation with Marcos Veremis of Cambridge Associates, one of the world’s leading asset allocation firms. Marcos discusses his views on hedge funds and the firm’s approach to selecting investment managers. We highly recommend the interview to managers interested in attracting institutional capital.

Marcos Veremis is a Managing Director with Cambridge Associates in London, working with a variety of investors such as universities, charities, international non-profit organizations, sovereign wealth funds, independent private schools and family offices on investment strategy, asset allocation, investment manager selection and financial planning issues. The job involves direct contact with investment committees and a very broad range of investment managers (venture capital, private equity, hedge funds, fixed income, real assets and equity) in order to make portfolio management decisions. Clients are based in the US, UK, Continental Europe and Africa. Author of two company white papers on equity short-selling (2010) and activist investing (2012).

The following transcript is provided for the convenience and enjoyment of MOI Global members. It has been edited for space and clarity.

John Mihaljevic, MOI Global: Such a pleasure to have with us Marcos Veremis, Managing Director at Cambridge Associates. We’re looking forward to this conversation in which we’ll cover a number of topics, including the construction of hedge fund portfolios. We’ll also go into short selling a bit. Before we get started or as we get started, could you tell us a little bit about your own background and the background of Cambridge Associates, please?

Marcos Veremis: Let me start with the background of Cambridge Associates and then you’ll see where I fit into the organization. Cambridge Associates is an investment advisory firm currently advising $400+ billion in assets of which $30+ billion is in discretionary mandate where we manage the assets directly [figures updated as of May 2019]. The firm started in the early ‘70s as a project for Harvard University, the endowment, from our two cofounders, Jim Bailey and Hunter Lewis. Hunter Lewis you might have come across in the press. He writes books and articles and so on on various topics related to finance. After that project was done, the firm started expanding into providing more services and to more universities.

As time went by, it became a full investment advisory firm. The vast majority of our clients are nonprofits at the moment, but we’ve also expanded into areas such as pensions and definitely ultra-high net worth individuals. That’s a big piece of the business and also sovereign wealth funds and all sorts of clients in Asia. We have one in Africa these days, too, in Continental Europe and, of course, the US.

What we is we create fully customized investment portfolios for our clients. No single portfolio is similar to another portfolio, they’re all different. If you look at the Cambridge portfolios and you look at various client portfolios, you’ll see that no one is identical. We offer fully customized solutions to clients and each portfolio is its own entity, which distinguishes, I think, Cambridge from most other investment advisory firms. One more important thing to note about Cambridge is that we’re fully independent and we also offer independent advice, conflict-free and independent advice. The managers we recommend, they don’t pay us. They don’t pay us to get on our databases, they don’t sponsor conferences. They pay us nothing and we don’t even accept gifts from them. We just try to present our best ideas and make returns for our clients. That’s the purpose of the firm.

Now my role in the firm, a little bit of background. I started pretty young at Cambridge Associates when I was 27, 28 years old. First, I was at Columbia Business School where I took a number of investing courses. As you know, John, Columbia Business School is the value investing birthplace, let’s say, with Ben Graham and Warren Buffett and so on. I did go there and I did take a class with Bruce Greenwald, for example, who’s written a number of books on value investing. It was natural for me to try to find a job at a firm like Cambridge Associates, which also has a value orientation in its investment approach, I think, overall.

The firm is broadly split into two areas with respect to consulting. One is the research consultancy arm and the other is the client-facing consulting arm. I’m in the client-facing consulting arm. What I do is I construct portfolios for the clients I work with. I use a lot of the information that the research team generates in terms of manager ideas and capital market ideas and so on, but I also do my own independent research and have my own favorite fund ideas about asset allocation and so on. I work together with my clients to develop portfolios. That’s, broadly speaking, Cambridge’s background and my background. Happy to answer anymore questions if something’s not clear.

MOI: Perhaps we could delve into the broad topics of asset allocation and portfolio construction. How do you think about it from a big picture standpoint?

Veremis: As a firm, Cambridge Associates back in the 1970s is a firm that actually founded the endowment model of investing alongside Yale and you probably know David Swensen and so on. There’s a specific philosophy behind that model that has worked very successfully over time and we believe is going to work very successfully in the future for reasons that I’ll explain. There are a couple of principles behind it. First, for a portfolio, we have a high equity component and whether it’s public equity or private equity, that’s where the growth is going to come from. Another principle is to have as much diversification as possible within a portfolio. As you know, diversification theory – it’s well-known by now – you can create a more efficient portfolio in terms of risk-adjusted returns by putting different asset classes together or differentiate the sources of returns, uncorrelated sources of returns. That’s the second principle.

The third principle is focusing more on value. Value typically will result across asset classes, over time if you implement it in a disciplined way, it’s going to generate higher returns. The underlying, broad reason behind that is that market participants tend to overpay for what’s popular and growing and tend to underpay for what’s out of favor. That said, we’re looking for managers that don’t just buy value passively, but have a very specific methodology in selecting the best value within value, let’s say. Then the fourth piece and very important is that within this equity-oriented portfolio, you need to have some hedges because you never know, especially in short periods of time, but even longer periods of time, you never know for certain that equity returns are going to generate what you need.

Take Japan during its deflationary period. You’ve got to have some deflation protection in a portfolio and you’ve got to also have some inflation protection in the portfolio. These weights can vary depending on valuations and general market conditions, so in a deflationary environment and depending on valuations, you might overweight, for example, the deflation hedges. This is the broad philosophy. That’s how you construct a portfolio. The first thing you do when you interact with a client is you try to understand what their needs are in terms of liabilities, what their liabilities are, what they want in terms of returns, how comfortable are they with volatility. Once you determine these parameters with a client, you can develop a long-term asset allocation based on asset class characteristics.

Around that model, asset allocation, you can create policy ranges, let’s say. Say you want to have, as a long-term portfolio, 70% in equities. You might say, “Give yourself some flexibility to be somewhat tactical,” 50% or 40% to 80% equity or 50% to 70% equity. It depends, it depends. From there, you want to actively rebalance. The rebalancing is very important and counterintuitive sometimes because you often take money away from managers or asset classes that have been performing better, which for many, many people is counterintuitive, but given the cyclicality of asset class returns and manager returns, rebalancing regularly actually increases the likelihood of you diminishing risks over time and even potentially enhancing returns.

MOI: Let’s go into hedge fund portfolios in particular. You have longstanding expertise in that area. How do you go about constructing those types of portfolios as well as how do you think about manager selection?

About The Author: John Mihaljevic

John serves as chairman of MOI Global, the membership community of intelligent investors. He is a managing editor of The Manual of Ideas, the acclaimed member publication of MOI Global. Previously, John served as managing partner of private investment firm Mihaljevic Capital Management. He is a winner of the best investment idea prize awarded by Value Investors Club. John is a trained capital allocator, having studied under Yale University Chief Investment Officer David Swensen and served as Research Assistant to Nobel Laureate James Tobin. John holds a BA in Economics, summa cum laude, from Yale and is a CFA charterholder.